The whole truth about copying trades
There are quite many services, which offer copying trades of successful traders and having a stable income from it. These could be PAMM, LAMM and MAM services or direct copying trades on your account. Is it possible to make money on it and how?
Read in this article:
- Is it possible to make money copying trades of other traders?
- Portfolio investing into several traders.
- Selection of traders into the portfolio.
- Analysis of trading systems and trading stories.
- Launching individual trading systems.
- Trading control and portfolio rebalancing.
- Trader portfolio risk management.
- How to become a successful trader and sell your trading signals?
1. Is it possible to make money copying trades of other traders?
Multiple services on copying trades of successful traders are positioned as a possibility to make easy and quick money in the financial markets without studying the trading science in depth. You just need to set copying trades on your account and that’s it. The money will flow to your account. Is it true?
Of course, it’s not that simple. Making money is not an easy job. Financial markets are not an exception. Services on copying trades do not tell you the whole truth about the real state of things:
- a non-professional investor is not able to conduct a quality analysis and select a stable trader for copying trades;
- you need to have special knowledge and experience for a quality trader selection;
- according to the study of Barber, Lee and Odean ‘Do Day Traders Rationally Learn About Their Ability’, a non-professional investor will lose his money in 99% of cases trying to copy trades of other traders;
- you need to form your portfolio from several traders, control trades and perform portfolio rebalancing in order to achieve stable operation;
- you need relatively big amounts (starting from USD 10,000) in order to invest into a trader portfolio. One or two thousand dollars obviously is not enough.
Could a non-professional investor make money in a stable manner copying trades of successful traders through the PAMM account services? Most probably, the answer is NO.
Could a professional portfolio manager make money in a stable manner copying trades through the PAMM account services? Most probably, the answer is YES.
It is important to understand that only an experienced trader, who is able to conduct deep analysis of the other trader operation, may successfully invest in other traders. To do it, he needs to have a sufficiently high level of qualification and such a level of a portfolio manager, who not only is able to trade in the financial markets himself but who is able to analyse and control somebody else’s trading.
Copying trades is not for a beginner trader or investor!
What direction do you have to move in if you want to master this type of investing? Let’s consider the sequence of steps.
Portfolio investing in several traders
The first step, which you should seriously consider, is the principle of portfolio investing, which means investing in several traders.
Why is it important for any trader or investor to form a portfolio of trading systems for investing?
Seven arguments in favour of a portfolio investing:
Argument 1. Market variability constantly makes looking for new approaches for profitable trading and, due to this, any trading system has the market lifetime, during which it is in correspondence with the current market and can bring profit. If you have only one system in your portfolio, then, most probably, it would stop working after some time.
Argument 2. Trader psychology may influence trading stability. If there is only one trader in the portfolio, then, due to emotional load and errors of the trade supplier, the portfolio may go into drawdown even if the market hasn’t changed.
Argument 3. One trader is one system. A trader may trade with proper quality only a small number of trading systems, usually, not more than one. That is why it is important to have several traders in the portfolio, so that trading could be carried out with different trading systems and instruments and in different markets.
Argument 4. Absence of multi-month drawdowns. Any trading system may go into drawdown and stay there for several months, which might not be very easy for an investor from the psychological point of view. If there are several traders in the portfolio, drawdown of one system could be compensated by the profit of another trading system.
Argument 5. Diversification. In order to make profit in a stable manner, it is necessary to diversify your investments into various trading systems, instruments and markets. Trend movements could take place at different times in different markets and you need to monitor and trade different markets in order not to miss the opportunity to make profit.
Argument 6. A smoother capital curve.
The capital curve of the portfolio may grow quieter and smoother than capital curves of separate systems by means of mutual compensation of losses and profits in the portfolio. And it is more favourable for an investor from the psychological point of view.
Argument 7. Low probability of the maximum drawdown. If the portfolio has several systems, the probability of appearance of the maximum drawdown in all systems at the same time is minor. Consequently, the portfolio may trade in a more stable fashion.
So, portfolio investing is the first step on the way to successful trade copying. One trader is not enough, you should find several traders and use them to compose an investment portfolio. And this immediately increases the amount from which you may start investing into this approach. To start with, you need USD 10,000 or more. The optimum amount would be around USD 30,000.
Selection of traders into the portfolio
The second step for successful investing is to make a preliminary selection of traders.
There are quite a lot of copying signals and PAMM accounts and hundreds of traders on these services, that is why we need to specify several criteria, by which we need to make a strict selection of the best traders.
Criteria for fast trader selection:
· Statement. The service should provide a possibility to download the trader’s statement and analyse it in Excel. Since not all indicators may be provided by the service, you would have to calculate something.
To conduct analysis, you should take traders with the trading history not less than 1 year, so that a trader could have shown his efficiency in various market phases.
· Capital curve should be systematically growing, fractal, which means that various capital curve areas should be similar, which shows that the trader’s system hasn’t been changed during the trading period.
· Drawdown shouldn’t be more than 30%, since it is difficult and psychologically hard for an investor to exit from a big drawdown. This also shows that a trader trades rather conservatively.
· Profit factor is an amount of all positive trades with respect to the amount of all negative trades and it should be more than 2. It shows that the system makes money in a stable fashion and the profit exceeds losses more than twice.
· Average trade gain should be more than the average trade loss. It shows that a trader possesses the so-called ‘alpha’, in other words, correct market entry and exit points and makes money with the help of correct analytics rather than capital management.
· Sharpe ratio assesses the trading system risk and reward relation and, consequently, it is necessary to include those traders in the portfolio who have the highest values of this ratio.
· Capital loading will help you to assess how much a trader uses aggressive capital management methods. The portfolio should include traders with a minimum capital loading, since such traders would trade in a more stable fashion and they would have a larger margin of safety in the event of market turbulences.
· Mathematical expectation of profit should be more than 3 points, so that the system could have been scaled for different accounts and different brokers. The higher mathematical expectation in points, the better and more profitable the trading system is.
Maximum 50 best traders could be selected out of 500 traders with profitable statements on the basis of such an analysis. And then you should continue their deeper analysis.
Analysis of trading systems and trading history
The third step in the profitable portfolio formation is a deeper trading analysis of those traders whom we selected.
Criteria of a deeper analysis:
· Mathematical and statistical analysis of trades. This stage requires loading the trader’s statement into Excel and calculating additional characteristics by statement. Some characteristics could be taken from services, if they are calculated by them.
The goal is to find stable traders. The following will help us to do that:
- % of profitable trades;
- average trade time;
- standard deviation in points;
- mathematical expectation in dollars, etc.
It is necessary to describe and digitize the trading system with the help of the instruments of statistical analysis and include the traders with the best statistics into the portfolio.
· Description of the trading system. It is necessary to put several dozens of trades in the chart and describe the trader’s trading system logic and your trading experience would be very valuable here. It is required for the further trader action control and understanding by means of what a trader makes money in the market. It is preferable to include those traders into the portfolio, who have different trading approaches for larger diversification.
· Capital management system description. It might be clear from the statement analysis whether a trader uses aggressive capital management methods – martingale, averaging, waiting out the losses, etc.
Example of a trader who uses martingale – there are specific ‘teeth’ in the capital curve due to high volume trading. You should avoid copying traders who use aggressive methods of capital management.
· Description of the risk management system. It might be clear from the statement analysis whether a trader uses stop losses, limits risks for a series of trades, day, week, month and maximum drawdown. The portfolio should include traders with a strict limitation of risks who do not allow losing the whole profit during one unlucky trading day.
A separate file with statement, statistics and description could be arranged for each trader based on the results of such an analysis. And only not more than 5 the most conservative and safe traders out of the best 50 may get into the portfolio.
Launching individual trading systems
After you formed your portfolio out of traders, it is necessary to start working with them, however, by a certain algorithm. Full-fledged launching from the start could bring losses.
Algorithm of putting traders into operation:
· Demo portfolio. After you select traders, you can make a demo investing into them in an Excel file. You should note down the current indicators and refresh information once a week / month. Having monitored the portfolio during 3 months, you would be able to assess the efficiency of your investments without losing a single dollar.
· Minimum volume. If the demo mode showed positive results, you could start investing real money in traders, however, you should start with minimum possible amounts. You should do it for 3 months to make sure, using little but real money, that your portfolio is efficient.
· Working volume. Then you can increase trading volumes of each trader once a month, reaching step-by-step the working volume of your portfolio. Capital shares, assigned to each trader, should be specified by the maximum drawdown, which a trader may tolerate in the worst situation.
Trading control and portfolio rebalancing
You should carry out trading control once a month after your portfolio entered the working mode. The goal of this control is to see that some ‘unhealthy process’ is going on with a trader and to exclude him from the portfolio before he makes losses. So, once a month you should analyse and control:
· mathematical and statistical indicators, which you calculated and analysed at the selection stage. If the trader’s statistics deteriorates, you should reduce his working volume or completely exclude him from the portfolio;
· algorithm of the trading system, the pattern of entry and exit points shouldn’t change and the system should stay stable;
· capital management and risk management should also stay within the previous trades, otherwise the complete trader’s previous statistics ceases to be representative.
You may do portfolio rebalancing after carrying out this analysis:
- reduce volume for traders with deteriorating indicators;
- clear the portfolio of those traders who changed the trading system or make constant losses;
· supplement the portfolio with those traders who passed the demo portfolio.
Traders’ portfolio risk management
Risk management is the main thing in the investing process. That is why it is necessary to use software in order to strictly control risks and remove traders from the portfolio if they exceed risks.
Basic risk management principles of the traders’ portfolio:
- Maximum drawdown of one system is not more than 30%;
- Exit from one system drawdown is not more than 6 months;
- The portfolio capital risk of one system is not more than 5% with 5 traders in the portfolio;
- Maximum risk for the whole portfolio capital is not more than 30%.
Such an approach would allow preservation of a big part of invested funds even if all traders simultaneously make losses.
How to become a successful trader and sell your own trading signals?
You may look at the trader copying service from the other side. You could try to become a profitable trader, attract capital and get payment/percent for trading signals by yourself. This variant is not simple either but, if you select the correct way, you can make it much shorter.
Analysis of trading volumes from regulated exchanges, for example, CME (Chicago Mercantile Exchange) would help you to understand actions of major market participants better and trade in the trend direction. Such an approach could significantly increase efficiency of even simple trading systems.
The trading ATAS platform contains many useful volume analysis indicators, which would help you to analyse volumes and actions of major market participants.
For example, the Cluster Search indicator:
This indicator is depicted as pink rectangles in the chart. It shows big ‘inflows’ of volume into the market, which often correspond with important market reversal points. This understanding can help a trader to create a correct trading strategy.
It is not easy to make money using the services of copying trades or investing in PAMM accounts. To do it you need knowledge, experience and time. These services are not for beginners. However, if you want to become a portfolio manager and manage your own portfolio consisting of profitable traders, then:
- Invest only in a portfolio since it is not sufficient for a stable operation to copy only one trader;
- Conduct analysis of hundreds of traders on the monthly basis, looking for talents;
- Deeply analyse trading systems and capital and risk management of your traders;
- Start working with new traders slowly through the demo portfolio;
- Analyse traders and rebalance your portfolio on the monthly basis, removing weak ones and adding strong ones;
- Strictly control your risks using software.
At the same time, move along the second way, becoming a profitable trader who sells his own trades and attracting investment capital using the trading ATAS platform, which will become your right hand in it.